Question

A finance company that lends to “high-risk” automobile buyers, finds the following variables important in classifying default probabilities: time at present residence, prior bankruptcy filing (yes or no), time in present job, monthly income, phone in name (yes or no), prior repossession of item purchased on credit (yes or no), and type of residence (e.g., apartment, rent house, purchasing house). Listing each variable, suggest whether each variable increases (+) or decreases (−) anticipated default risk, and how you would evaluate the type of residence in assigning creditworthiness to applicants. please describe briefly. Thanks.

Answer 1

Default risk is the probability of the borrower to skip the payment of EMI on finance taken for purchase of Automobile because normally in automobile loan the finance company does not take any collateral but looks at the credit score of the buyer and the following variables in classifying the default probabilities

·         Time at present residence – If the buyer stays longer than one year at the present residence the anticipated default risk decreases because it would easy to enquire from the neighborhood the spending habits of the buyer and less risk of buyer shifting to new location without any notice

·         Prior bankruptcy filing (yes or no)- if yes than default risk is increases as the chances of buyer not able to pay the EMI increases and can again go for Bankruptcy filing . If no then the default risk decreases

·         Time in present job – The higher time in the present job or stability in the job decreases the default risk normally financiers take into account minimum one year in the present job. If the buyer is changing the jobs frequently less than one year the default risk increases

·         Monthly income,- If the monthly income is high and the EMI other loans are 50% of monthly take home salary then if automobile loan is given the default risk will increases . If there no other loan and only automobile loan which is less than 10% of take home salary than default risk decreases

·         Phone in name (yes or no), - If phone is in buyer name default risk decreases and if not the default risk increases

·         Prior repossession of item purchased on credit (yes or no), - If prior repossession of item purchased on credit is yes means due to nonpayment the item is taken back by the financier hence if this is case the default risk increases . If not than the default risk decreases

·         Type of residence (e.g., apartment, rent house, purchasing house). – if buyer is having its own apartment and there is no mortgage than the default risk decreases and buyer is creditworthy

If it a rented house and the house rent is 20% of take home salary than the buyer is creditworthy bit it is more than 50% of take home salary than default risk will increases

If the buyer is purchasing the house normally the mortgage would be 60% of home take salary on top of it he goes for automobile loan than default risk increases